Blockchain Regulation in Finance: Recent Developments and Prospects

Blockchain technology is a nascent innovation that is
providing evolving applications in finance every day.

Several regulators have already signaled their intention
to examine the use of blockchains. While potentially attractive to regulators
due to increased transaction security and reduced risk of manipulation, this
new technology gives rise to difficult legal and regulatory challenges that
regulators are grappling to understand. While regulations for such a new
technology are always in flux, this short article analyzes the current regulatory
approach to blockchain technology.

A Brief Overview of the U.S. Regulatory Environment

U.S. regulators are closely monitoring the development
of blockchains and other distributed ledger technologies (as well as the virtual
currencies exchanged on them). Some have expressed concerns regarding their
impact on financial stability and market integrity.

Among U.S. regulators, the U.S. Securities and Exchange
Commission (SEC) has been actively exploring potential applications of blockchains
for financial services transactions in the public securities market. In a
November 2015 speech, Commissioner Kara Stein first touted the potential of blockchains
for tracing securities lending, repo and margin financing and monitoring
systemic risk by, for example, overseeing
collateral reuse.However, Commissioner Stein also cautioned
that as the market embraces blockchain technology, "regulators need to be
in a position to lead, harnessing its benefits and responding quickly to
potential weaknesses." Moreover, the SEC has embraced the early adoption
of blockchains as it relates to securities using its t0.com blockchain
platform.

The Commodity Futures Trading Commission (CFTC) is
another U.S. regulator examining how blockchain and distributed ledger
technology could be used in the derivatives market. In March 2016, CFTC
Commissioner J. Christopher Giancarlo discussed
the emergence of distributed ledger technolgoy and stressed the importance of
adopting a "do not harm" regulatory approach that establishes
"uniform principles in an effort to encourage [distributed ledger
technology] investment and innovation."

More formally, the CFTC Technology Advisory Committee
(TAC) meeting held in April 2016 included a
blockchain panel. The TAC noted that the lack of industry standards to date
is a result of the fact that blockchain technology is still emerging and their
implementation will be incremental.

The Financial Crimes Enforcement Network (FinCEN) is
another U.S. regulator issuing administrative rulings and interpretive guidance
regarding virtual currencies and blockchains. FinCEN issued
a ruling that an online precious metals brokerage using blockchain technology
was subject to the regulator's money transmission regulations.

Most recently, the Office of the Comptroller of the
Currency (OCC) warned in its semi-annual risk
survey that virtual currencies "enable anonymity for cyber criminals,
including terrorists and other groups seeking to transfer and launder money
globally."

Other U.S. agencies such as the Federal Trade
Commission (FTC) and the Consumer Financial Production Bureau (CFPB) have
brought enforcement actions and issued warnings to consumers regarding the
risks associated with bitcoin and virtual currencies more generally.

A Brief Overview of the European Regulatory Environment

The European Securities Market Authority (ESMA), which
is the umbrella of all national securities commissions in Europe, published a
discussion paper in June 2016 entitled "The Distributed Ledger Technology
Applied to Securities Markets" which addresses potential benefits and
risks that distributed ledgers could have on securities markets, especially
from a public policy perspective.

In the U.K., the Financial Conduct Authority (FCA) has
been extensively involved in fintech through the development of a regulatory fintech
sandbox. The approach has largely been to watch and see how the technology
develops. The FCA has recently published a discussion paper entitled
"Discussion Paper on Distributed Ledger Technology," in which it
calls for comment on the risks, uses and opportunities for the development of
distributed ledger technology in the financial sector. The paper looks at the
use of distributed ledger technology in the context of shared database models,
digital currencies, digital asset trading and initial coin offerings, amongst
other things, with a view to if and how regulation should be applied to the uses
arising from the development of the technology.

Moving Froward from a Regulatory Perspective

It is clear that regulators will pay close attention
to the development and use of DLT in the regulated sector. Regulators have
generally avoided regulating technology itself and have paid attention to the
uses and products that may be promoted or developed across the technology
platform.

Whilst the market monitors potential regulatory
developments, effective governance is the key to the successful implementation
of distributed ledger technology to protect participants, investors and
stakeholders whilst ensuring that the system is resilient in the face of
systemic risk, privacy concerns and cybersecurity threats.

The development of the regulatory approach is still
unclear, but it is incumbent on the industry as a whole to monitor applications
to which blockchains may be put and avoid products and processes that are
abusive or will lead to systemic risk. Otherwise, we can expect heavy-handed
regulation that will limit the future development of the technology and the
benefits it can provide.

Martin Bartlam is a partner based in the London office of DLA
Piper and is the head of the firm’s Finance and Projects, International
Practice. Mark Radcliffe is a partner based
in the Silicon Valley office of DLA Piper and the former head of the firm’s Technology
Sector.